Corporate finance tri vi dang columbia university

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Unformatted text preview: : PV E[ x i ] 1 ri where cov(x j , m) ri rf ( M rf ) βi rf ( M rf ) σM ² Corporate Finance, Tri Vi Dang, Columbia University, Fall 2013 36 Implications The equilibrium interest rate we can use to discount expected payoff depends on the Beta of the project. The higher is beta (i.e. the covariance between the project payoff and the payoff of the market portfolio), the higher the interest rate. In other words, if a project is positively correlated with the market, agents require a higher interest rate. Corporate Finance, Tri Vi Dang, Columbia University, Fall 2013 37 Remark M rf : market risk premium (and it is positive empirically) The risk premium of asset i: i rf ( M rf ) β i Implication i rf if β i 0 i rf if β i 0 i rf if β i 0 Corporate Finance, Tri Vi Dang, Columbia University, Fall 2013 38 CAPM and project choices Suppose a firm has a project i with β i . Suppose the expected return of the project is E[ri]. E[ri ] rf ( M rf ) β i , then do the project. If Equilibriu return m Otherwise, do not do the project. If you invest your money and buy an asset with the (same) β i , you get a higher expected return. C...
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